ASD Macroeconomic Model of Japan
on the Flow of Funds and National Accounts
Report on its Early Stage Development
Kaoru Yamaguchi *
Yokei Yamaguchi
Japan Futures Research Center
Awaji Island 656-1325, Japan
E-mail: director@muratopia.net
Abstract
This paper tries to report the early stage development of our ASD (ac-
counting system dynamics) macroeconomic model of Japan. The model
incorporates financial sectors to show that demand deposits or credits are
created out of nothing or destroyed endogenously under the current frac-
tional reserve banking system. To be specific, 15 macroeconomi
are consolidated to the model with more than 1300 variables by incorpo-
rating the Flow of Funds Accounts by the Bank of Japan. The difficulty
we faced is that inflow and outflow data for financial transactions are not
available and we are obliged to reconstruct all financial inflow and outflow
transactions by our economic rationale.
Our modeling purpose at this early stage is focused on the macroeco-
nomic system structure that caused Japanese economic recession of two
decades long despite of the quantitative easing (QE) policies. From the
analysis of imported financial data to the model, we found a dramatic
change in the roles of economic players; that is, credit creation roles have
shifted from producers and households to the government, followed by
accumulating debt crisis.
Finally a partial optimization is successfully performed for the inter-
polation of real macroeconomic behaviors such as GDP, consumption,
investment, price, prime rate, unemployment rate, employed labor, and
population. Its success will enable ” what-if ?” analysis of macroeconomic
behaviors at the next stage development in the future.
ectors:
“The first author is the director of the Research Center, and the second author is its student
her, currently studying at the European Master Programme in System Dynamic This
s Si
"July 20, 2015. ‘This research is partially supported by the
Research Fund of the Japan Futures Research Center.
1 Need for Financial Modeling
1.1 Unstable Economic Behaviors
At the international SD conference in Delft, the Netherlands last year, one of
the author presented the paper [4, 2014] that shows a transition process from
the current debt money system to the public money system by constructing
a simple SD macroeconomic model for transition. Then, current debt money
system is identified as having system design failures, and proposed to be replaced
with more fic, current monetary
em has been pointed out to contain two major design failures. First, it
uses booms and depressions (and unemployment), or inflation and deflation
led fractional reserve banking s: , which creates credits (or
demand deposits) out of nothing and incessantly destroy them, causing unstable
money stock (which is defined as the sum of currency outstanding and demand
dep. in the economy.
Second, it causes to accumulate government debt. Under the current debt
money system, someone has to borrow money to increase money stock for eco-
nomic growth. And government has to be the last and the only borrower for a
longer period, in the world.
These two system design failures have become the root causes of economic
under the current debt money system. The only cure within the sys-
tem has been to introduce the so-called financial quantitative casi
, which has also unfortunately failed to relieve economic diffic’
ions and unemployment.
able system of public money. To be spe
ca
due to the so-c
booms and depressions, and debt
Trillion Yen
Currenc
2 4 Outstanding 12 14 16 18 20 22 24 26 28 30
Time (Year)
Monetary Base : Current
Money Supply : Current
Currency Outstanding : Current
“Debt (Government)” + Current
Figure 1: Simple Behaviors of Debt Money System
These structural failures of the current monetary system are very succinctly
described in terms of system behaviors of monetary base and money supply. For
this purpose, a simple SD macroeconomic model is developed to illustrate such
unstable monetary behaviors as shown in Figure 1. Monetary base is described
by the bold blue line 1, which consists of currency outstanding (green line 3)
and reserves of commercial banks at the central bank. Money stock (or supply)
M, is described by the red bold line 2, which indicates unstable behaviors of
money stock. The pink bold line 4 illustrates how government debt is forced to
be increased.
The financial QE policy mainly consists of the purchase of governmental and
commercial securities by the central bank. In exchange, reserves of commercial
banks are increased so that banks could expand their credit creation by making
loans, thus increasing money stock with a hope that this policy stimulates eco-
nomic activities out of recession. An increase in monetary base (blue bold line
1) around the year 25 in the above figure indicates the introduction of the QE
policy. Yet, this increase in monetary base has failed to increase money stock
M4, which, in turn, has failed to stimulate the economy as expected.
1.2 Failures of Financial QE Policies
To confirm actual behaviors of these monetary movements in relation to money
stock by QE policy, real monetary data are taken from the Bank of Japan.
Figure 2 illustrates the time-series behaviors of monetary base in Japan since
Figure 2: Monetary Base and M1: BOJ Data as of 2015.07
2004 through April of 2015. Specifically, it illustrates how Japanese monetary
base has increased since the Bank of Japan began to reintroduce its new QE
policy in April of 2013. The BOJ purchased significant amount of government
securities and others to increase its monetary base by 131.3 trillion yen since
then through April 2015. Accordingly the monetary base has increased by 150.8
trillion yen during the last two years from 149.5 trillion yen to 300.3 trillion yen.
Yet, money stock Mj only increased by 57.2 trillion yen from 560.9 trillion yen
to 618.1 trillion yen. Money multiplier, which is a ratio between money stock
and monetary base, was 3.75 two years ago. If it would have stayed stable as
most QE policy makers had expected, the increase in monetary base by 150.8
trillion yen could have increased money stock by the amount of 565.5 trillion
yen! Yet, it only increased by 57.2 trillion yen, surprisingly smaller than the
increase in monetary base itself. In other words, if this increase were to be done
as helicopter money, it would have increased money stock at least by the same
amount of 150.8 trillion yen. Traditional macr ic theory has completely
failed to explain this failure.
Concurrently QE policies have been heavily applied to the depressed economies
of U.S and EU countries as the last resort of financial policy to stimulate their
economies. Unfortunately, they have also failed as in Japan.
Figure 3: Why QE failed to Stimulate M1
What went wrong, then? Under the current fractional reserve banking sys-
tem or simply debt money system, money stock (or simply, deposits) can be in-
creased only when someone comes to borrow money from banks. That someone
could be producers seeking for investment, households for housing investment,
or the government to meet its budget deficits. Figure 3 illustrates to whom com-
mercial banks in Japan made loans since 2004. Specifically, during the last two
years when the QE policy was heavily conducted, bank loans to corporations
increased only by 1.9 trillion yen (0.5%) from 418.5 trillion yen to 420.4 trillion
lly lower interest rate of close to zero
nilable by the QE policy, non-finar
failed to borrow from banks. In addi-
yen. This implies that, despite a histori
and abundance of monetary base made d
corporations(hereafter called produc
tion, bank loans to households (including sole proprictorships) during the same
period increased only by 4.4 trillion yen (1.4%) from 305.8 trillion yen to 310.2
trillion yen. Under the recessions, houscholds also didn’t expand its borrowings
due to their gloomy expectations that their income wages may not increase, or,
to be worse they may lose jobs. These concerns of households withheld their
borrowings for housing and investment.
Compared with these depressed borrowers, only the government sector is
obliged to increase their borrowings due to its budgetary deficit even though
umulate a huge amount of debts in the near future. In other
words, only the government had no choice but to keep borrowing. Accordingly,
the increase in monetary base by the QE policy of the BOJ turned out only to
monetize the government debt, en route to the borrowings through commercial
banks. Hence, the QE policy has essentially become the debt financing policy of
the government, though it is prohibited by law. How long can the government
continue to borrow? And how long can the central bank endure such absurdities?
With fears of collapse, quite a few central banks are now trying to find out
exits from QE policies to save themselves, not the troubled economies. These
exoduses in turn will surely cause the governments and economies to collapse.
We are indeed trapped into the dead-end financial system.
ial
it fears to ¢
1.3. Search for the Causes of QE Failures
With these imminent economic situations we are facing now, the real question we
have to be able to answer should be what went wrong with the current economic
8}
stem structure that has made such QE policy failures. Unfortunately, to the
best of our knowledge, no financial models are available to identify structural
causes of such failures. The above simple SD model presented at Delft SD
conference last year is too simple to better understand the system design failures
discussed above. It would be nice, we thought, if we could build a comprehensive
SD macroeconomic model, based on the method,
that integrates financ q : This has
become our main motive to develop the ASD macroeconomic model of Japan
in this research.
For this development, the Flow of Funds Accounts (hereafter called the FFA)
by the BOJ turned out to be very powerful data source for observing financial
transactions in Japan. For the integration of financial sectors with the FFA,
the SD macroeconomic model presented in Chapter 9 of the book [3, 2013]
turns out to be the best generic modeling framework, because it is built on
the accounting system dynamics method, which is close to the FFA approach
due to its dependence on the 1993 SNA (System of National Accounts) by the
United Nations. So far, however, no such ASD macroeconomic models have been
developed to incorporate the FFA. Since the FFA covers a huge data matrix
of the financial transactions in the Japanese economy as explained below, our
esearch is broken down into several stages of development.
Stage 1 Construction of an ASD macroeconomic model that reflects transactions of
real and financial economic sectors, and examination of model consistency
among all inflow and outflow transactions across all sectors.
Stage 2 Incorporation of real economic and financial data into the model as ref-
erence and data variables. Upon its completion, the ASD model could
become a prototype for world-wide national models.
When these two stages are done, the model
used for understanding inter-
data at hand.
If could be independently
toral transactions with actual Japanese
Stage 3 Partial Optimization of interpolation for real economic behaviors such as
GDP, consumption, investment, price, prime rate, unemployment rate,
employed labor and other variables with a hypothesis that structural
changes are reflected among their exogenous paramete
Stage ‘k relations
Construction of detailed interdependent feedba
tors in order to make exogenous parameters
ible.
among all
in Step 3 endogenous as far
as possibl
Stage 5 Wholistic simulation anal:
policy failures
fiscal and monetary polici
s to figure out the structural
traditional analyses for the effects
, as well a
Stage 6 Comparative analyses for the workings of debt money and public money
This paper tries to cover the early stages of the ASD model development as
far as the stage 3 partially.
2 Revisit of the Macroeconomic Model
For the continuity of model development, let us now revisit the SD macroeco-
nomic model presented in the Chapter 9 of "A Macroeconomic System” in the
book [3, 2013]. Its basic framework is illustrated in Figure 4. It shows that the
of five me ectors such as producers, consumers,
economic
economy con
government, banks and central bank.
For the convenience to the reader, let us briefly desc
among the
ibe major transactions
ive ‘tors.
To the best of our know
, an applied macroeconomic model based on the chapter 9
is developed to the Croatia macroeconomy by Sinisa Sovilj and Marina Tkalec, which was
presented at the Poster session of the 32nd International Conference of the System Dynamics
Society, Delft, Netherlands, 2014. It is a simple application of the model in Chapter 9, and
no attempt is made to incorporate the Flow of Funds Accounts we are challenging in this
research.
Figure 4: Macroeconomic Overview of Chapter 9
Producers
Major transactions of producers are summarized as follows.
« Producers import goods from overseas and export them to overseas.
Out of the GDP revenues producers pay excise tax, deduct the amount of
depreciation, and pay wages to workers (consumers) and interests to the
banks. The remaining revenues become profits before tax.
They pay corporate tax to the government out of the profits before tax.
The remaining profits after tax are paid to the owners (that is, consumers)
as dividends.
e Producers are thus constantly in a state of cash flow deficits. To continue
making new investments, therefore, they have to borrow money from banks
and pay interest to the banks.
Consumers (Households)
Major transactions of consumers are summarized as follows.
« Consumers receive wages and dividends from producers.
ist of bank deposits and government
securities, against which they receive financial income of interests from
banks and government.
Financial assets of consume
cons
In addition to the income such as wages, interests, and dividends, con-
sumers receive cash whenever previous securities are partly redeemed an-
nually by the government.
Out of these cash income as a whole, consumers pay income taxes, and
the remaining income becomes their disposal income.
pend on consumption. The remaining
urities or saved.
Out of their disposal income, they
amount are either spent to purchase government ¢
Government
Mi follow:
jor transactions of the government are summarized
« Government receives, as tax revenues, income taxes from consumers and
corporate taxes from produ
cers.
¢ Government spending consists of government expenditures and payments
to the consumers for its partial debt redemption and interests against its
securiti
¢ Government expenditur sumed to be endogenously determined
by either the growth-dependent expenditures or tax revenue-dependent
expenditures.
e If spending exceeds tax revenues, government has to borrow cash from
consumers by newly issuing government securities.
Banks
Major transactions of banks are summarized as follows.
Banks receive deposits from consumers, against which they pay
They are obliged to deposit a portion of the deposits as the required
reserves with the central bank.
Loans are made to producers out of the remaining deposits and banks
receive interests for which a prime rate is applied.
¢ Their retained earnings thus become interest receipts from producers less
interest payment to consumers. Positive earnings will be distributed among
bank worke:
's as consumers.
Central Bank
Major transactions of the central bank are summarized as follows.
The central bank issues currencies against the gold deposited by the public.
@ It can also issue currency by accepting government securities through open
market operation, specifically by purchasing government securities from
consumers.
e It can similarly withdraw currencies by selling government securities to
the public.
with
central
Banks are required by law to reserve a certain amount of deposi
the central bank. By controlling this required reserve ratio, the
bank can control the monetary base directly.
3 Modeling Processes of Credit Creation
3.1 Stock Approach
ASD macroeconomic models pr
in Chapter 9, differ from the current mainstream macroeconomic models
as neoclassical DSGE (Dynamic, Stochastic General Equilibrium) models and
Keynesian econometric models in the that (1) ASD models are all based
on the accounting system dynamic: name indicates, (2) demand deposits
(credits) are endogenously created in the economy as a part of money stock, and
(3) they are disequilibrium models. These different features are made possible by
the analytical method of the accounting system dynamics presented in Chapter
3 in [3, 2013].
Under this anal
credit creation are
sented in the book [3, 2013], including the one
such
s of
2 two
tical method, however, two distinct modeling pro
Chapter 5 of the book explains th
proc y, a traditional (or textbook) flow approach and
stock approach. In the traditional flow approach of credit creation, banks make
loans out of the deposits they receive from households. In the stock appro:
on the other hand, banks first make loans with credits given to the borrowers
accounts out of nothing. In case the amount of deposits thus created exceeds
shown to e:
ses in detail; that is to
the required reserves at the central bank, banks are forced to make adjustments
through inter-banking borrowing and lending after the loans are made. This
stock approac ial banks.
Recently, quite a few economists began to emphasize that the traditional
textbook approach is completely inaccurate and that loans are only handled
through the stock approach in everyday transactions. Specifically, researchers
at the Bank of England have recently emphasized the importance of this stock
approach in [2, 2014].
Chapter 5 of the book, however, demonstrates with ASD macroeconomic
models that these two approaches to the c
al transactions practiced by commer
cation of credits are equivalent at
at the
microeconomic level of transactions. Accordingly, in our research here we have
decided to build the ASD macroeconomic model of Japan by the stock approach
of credit creation. This approach would be better for handling real financial
transactions among banks on which the FFA data are based.
Major changes in building the ASD model by the stock approach take place
in the treatment of money stock. Under the textbook (flow) approach, demand
deposits and time deposits are not strictly distinguished and all transactions
are assumed to be done through the payment of cash. Accordingly, savings are
made out of cash and deposited with banks. Under the stock approach, money
stock has to be conceptually distinguished among cash (currency outstanding
or in circulation), demand deposits, and time deposits. As a result, major
transactions are assumed to be made through demand deposits, and savings as
time deposits are made out of demand deposits.
the macroeconomic level, though the stock approach is more realisti
3.2 Two Types of Loans
Following the stock approach, it is observed that there are two different types
of loan made in the economy. Loans are usually considered to be made by
ent amount of money or funds to lend out. Under the
fraction reserve banking system, however, loans are made out of nothing. The
stock approach is introduced to model the dynamics of such credit creation by
cock. However,
those who have suffix
banks. Loans thus made by banks increase money
of loans are only a part of loans made in real econom
absolutely necessary to distinguish the following two types of loans in our model
development.
Credit-creating Loans by Banks
This type of loans are made by banks under the fractional reserve banking
ystem out of nothing. It leads to the creation of new credits or demand deposits
in the economy, thus directly increasing money stock. This type of loans first
creates demand deposits both in the balance sheets of banking sectors and non-
nking sectors.?
Then, newly
as wage payment:
financial investment, or end up with households
cated deposits are transferred by producers to the households
for example, which will then be used for consumption or
wings. Whenever this type of
loans are repaid, credits or demand deposits will be destroyed simultancously.
This is one of the most important economic behaviors under the fractional
reserve banking system as repeatedly analyzed by monetary reform economists
such as Irving Fisher and others in 1930’s and 1940’s. See, for instance [1].
Followings are examples of
2 Technically speaking, loans receivable are debited and demand deposits are credited in
Bank’s balance sheet. At the same time, demand deposits are debited and loans payable are
credited in Producer's balance sheet. Most of economic transactions in the ASD macroeco-
nomic model are described in this manner, which is in line with double entry bookkeeping
rule. For more details, see Chapter 3 of the book(3, 2013]
loans made by banks.
10
Loans made to producers and government.
Loans made to other financial institutions.
Loans made to households and sole proprictors.
Non-Credit-creating Loans by Other Financial Institutions
In addition to the loans explained above, there is another type of loans made
by other financial institutions than banks. This type of loans requires such
institutions to have sufficient funds beforehand or borrow funds from banks or
. Contrary to the credit i is type of
money stock. Followings are examples of such type
other lenders to make loa
loans do not directly affec
of loans.
Loans made by insurance compani
Loans made by pension funds.
¢ Loans made by other financial intermediaries such as securities invest-
ment trusts, nonbanks, public financial institutions, financial dealers and
brokers, or government social security funds.
3.3. Another Way of Credit Creation
According to the article by the Bank of England(2, 2014], credit cre
in addition to bank loans. For example, banking sector usually buys and holds
ets on their
tion occurs
government bonds as part of their portfolio management of liquid
balance sheets. When banks purchase government bonds from non-bank private
or they credit the seller with bank deposits, leading directly to the increase
: is another important way in which financial investment
sates credits out of nothing.
4 Flow of Funds Accounts
The Bank of Japan provides a large amount of financial transaction data for
the use of researchers and financial analysts. It is called *The Flow of Funds
Accounts” (hereafter called the FFA). It is explained in the Guide to Japan’s
Flow of Funds Accounts® as follows.
The FFA is based on the System of National Accounts 1993 (the
1993 SNA), a new international standard for national accounts that
includes the FFA and Monetary and Financial Stat:
(the IMF Manual), compiled by the IMF, to standardize financial
statistics. The 1993 SNA and the IMF Manual set the
Manual
3Guide to Japan’s Flow of Funds Accounts is available at
https://www.boj.or.jp/en/statistics/outline/exp/exsj01.htm/
11
rs and transaction items that will be common in
, which the FFA has basically embra
the FFA conceptually contributes to part of the mac
SNA) that recor
concept of statisti
in Japan (p.3).
criteria for s
various countries
ced. Therefore,
the
9 statistic
and it:
's consistent with that of the national accounts
‘countrys economic activitic
4.1 Sectors
The FFA is provided in the matrix format. The columns into which economic
entities are classified are known as ” sectors.” They are broadly divided into six
sectors (numbered 1 through 6 in the
broken down into sub-s
below), and these sectors are further
ectors. In total there are 45 sec
Our research hi ed 15 sectors and sub-s
players for describing financial transactions in the macroeconomy of Japan. A
cording to the FFA numbering below, they are 1-1, 1-2-1, 1-2-2, 1-3-1, 1
1-4-1, 1-4-2, 1-4-3-1, 1-4-3-2, 1-4-4, 2, 3, 3-3, 4, 6.
‘ors?
ors as essential economic
1. Financial institutions
1-1 Central Bank
1-2 Depository corporations
1-2-1 Banks
1-2-2 Postal Savings
1-3 Insurance and pension funds
1-3-1 Insurance (called here Insurance Companies)
1-3-2 Pension funds
1-4 Other financial intermediaries
1-4-1 Securit
1-4-2 Nonbanks
1-4-3 Public financial institutions
1-4-3-1 Fi
1-4-3-2 Government financial institutions
1-4-4 Financial dealers and brokers
‘Ss investment trusts
1 loan fund
2. Non-financial corporations (called here Produce:
2-1 Private non financial corporations
2-2 Public non financial corporations
3. General government
“Data series of ” Postal
until the third quarter of 2007
ings” and ”Private life insurance companies” are available only
3+1 Central government
3-2 Local government
3-3 Social security funds
4. Households
5. Private institutions serving | holds (neglected in our model)
6. Overseas
14a.
a
1443. Pale Financia
=
Gerernnent
Financial tiation
Figure 5: List of Sectors on the Flows of Funds Account
Three remarks may be necessary here. First, a financial sub-sector called
» Other financial intermediaries” includes the following in our model: securities
investment trusts, nonbanks, fiscal loan fund, government financial institutions,
and financial dealers and brokers. Major players of the financial dealers and
brokers are securities companies (1-4-4-1). Second, though corporations are
13
ed above as consis
lis ing of private (2-1) and public (2-2) sub-sector:
jointly treated as producers (2) in our model. Third, though social s
funds(3-3) is part of the general government(3), it is separately treated
independent sub-sector in the model without losing gencrality, partly because
there are few overlapping transactions with general government(3), and partly
because its major sub-sector, known as the Government Pension Investment
Fund (GPIF), has been playing an important role recently in the Japanese
financial markets. Figure 5 illustrate: 1 and government sub-sectors
incorporated in the model by orange-shaped boxes.
hey are
curity
an
ch financi
4.2 Transactions
In the FFA matrix, items in the horizontal lines into which financial instruments
(transact s or liabilities) are cl
items.” They consist of totaled items such
Loans”, ”D. Securities other than share:
”G. Insurance and pension reserv
In total, there are 51 transaction items
which basic transaction items are 45.
Hence, there are 51 rows (transactions) and 45 columns (sectors) in the FFA
matrix, that i 295 matrix cel Accordingly, time series data from 1980
through 2014 includes total data of 80,325. If it is quarterly data, it contains
321,300 data.
Thus, the Guide to Japan’s FFA writes "Such detailed classification allows
users to rearrange the classifications in various ways in order to obtain different
perspectives of the flow of funds (p. 2).”
To avoid detailed complexities, 23 transaction items are selected as
for our model. They appear counting stock items in a
of the balance sheets of the selected 15 sectors. More specifically, they show up
under the following names in the balance sheets.
ed are known as "transaction
A. Currency and deposits”, °C.
”E, Shares and other equities”, and
and their sub-items.
(matrix rows) in the FFA, among
Sas
5
ential
and liabilities
A Currency and deposits
A-a Currency (renamed here as Cash)
A-b Depos
A-c Government deposits
with the Bank of Japan (renamed here as Reserves)
A-d Transferable deposits (renamed here as Demand deposits)
A-e Time and Savings deposits (renamed here as Time deposits)
B Deposits with the Fiscal Loan Fund
C Loans
C-a Bank of Japan loans (renamed here as Central Bank Loan)
C-d Loans by private financial institutions
C-d-a Housing loans
C-d-b Consumer credit
C-d-c Loans to companies and governments
C-e Loans by public financial institutions (of which: C-e-a housing loans)
D Sccurities other than shares
D-a Treasury discount bills
D-b Central government securities
D-c Local government securities (to be included)
curities
D-d Public corporation s
D-f Industrial securities
D-i Investment trust beneficiary certificat
ic)
Shares and other equities (renamed here as Capital Stocks)
G Insurance and pension reserves
G-a Insurance reserves
G-b Pension reserves
K Outward direct investment (renamed here as Foreign direct investment
Outstanding)
i
Outward investment in securiti
vestment Outstanding)
renamed here as Foreign Financial In-
So far we have only discussed data in the FFA. For a comprehensive ASD
macroeconomic model, of course, more data are called for from government data
sources such as national macr ic accounts, population as well as labor
fore are presented later in section 7.1.
etc. List of various model data sour
5 Expanded Financial Transactions
5.1 Financial Transaction of the Original Five Sectors
Integration of additional financial sectors and overseas detailed above has caused
expanded financial transactions among the original five sectors of the model (in
Chapter 9) to interact one another, simply because all macroeconomic transa
tions and activities
transactional changes caused by the integration of financial
are interrelated one another. Let us briefly describe these
ors.
15
Producers
In the model, imports and exports are treated as exogenously defined flow value:
Additionally, following transactions of producers are newly added.
¢ Producers now raise funds from Financial Dealers and Brokers by selling
corporate bonds and issuing new stocks in addition to loans from banks.
e Those newly issued stocks are considered to be traded within sector itself
or between different sectors.
Households (previously called Consumers)
Following transactions of households are newly added.
Households now additionally pay insurance and pensions out of their dis-
able income.
s with loans from
They make housing investment for building new hov
banks and other financial institutions.
¢ They borrow, if necessary, consumer credits from banks and other financial
itutions to balance their budgets.
ins
The remaining incomes after these transactions are saved as time depos
out of which portfolio investment are made between corporate stocks and
© Retired households also spend on consumption by withdrawing their time
deposits.
Government
Following transactions of the government are newly added.
e Government makes public investment in addition to its previous expendi-
tures.
¢ Government now raises funds by issuing treasury securities and treasury
bills to meet its budget.
« In addition to taxes, the government also collects public pensions for social
insurance program and pay annuities to houscholds.
e Part of public pension funds all collected from households sector are trans-
security funds sector.
ferred to soci
16
Banks
Following transactions of banks are newly added.
Banks now make loans by creating credits (demand deposits) to produc-
ers, households (as housing loans, consumer credits loans and loans to
companies), financial dealers and brokers, nonbanks, and other financial
institutions.
All transactions with government that are handled by the central bank are
now made through excess reserve deposits accounts of banks at the central
bank. Some examples of this kind of transaction are, for example, their
investment in government
households when receiving annuities from government.
Central Bank
nancial trans
sed through central bank. Therefore, central bank
tors and publi
ions are newly added.
model are ultimately proc
works as a financial bridge between private
government(3). Accordingly, following trans
ctor such as
¢ Central bank now handles government transactions, as government’s bank,
through government's deposit account that is opened at the central bank.
Central bank now allows "financial dealers and brokers” to open their
reserves accounts for their transaction of government securities and so on.
e In addition to its banking functions, central bank also tries to affect in-
terbank rate through changing its policy rate.
The Bank of Japan has historically issued its own stock called ”Shussi
Shoken” in Japanese, which literally means "Investment Securities” and are
similar to corporate capital stocks are traded daily in the JASDAQ
stock exchange market under the code 8301. This implies that the BOJ is not
a government institution. At this stage of our model development, howe
use the amount of these transactions has
er,
5.2 Transactions of Newly Added 10 Sectors
‘ors mentioned above, we have added the following ten
ctors to our model according to the above FFA classifi.
To the original five
more sectors and sub-s
cation as follows:
* Postal Savings (1-2-2)
* Insurance Companies (1-3-1)
* Pension Funds(1-3-2)
* Securities Investment Trusts(1-4-1)
* Nonbanks (1-4-2)
* Fiscal Loan Fund (1-4-3-1)
* Government Financial Institutions (1-4-3-2)
* Financial Dealers and Brokers (1-4-4)
* Social Security Funds (3-3)
* Overseas (6)
Postal Savings
Postal Savings
and perhaps a unique se
ctor is listed as part of depository corporations(1-2) in FFA
ctor to Japan. Postal s to the Japan Post
Postal Savings Services (former Postal Savings Spe: at takes in
savings deposits and manage investments as postal s _ its basic
structure resembles that of banks, though it has more publ. . It is
reorganized as a private company called the Japan Post Bank in October 2007.
Consequently, the data of the ”Postal savings” sector are no longer available
from the fourth quarter of 2007 due to its sectoral change from Postal Savings
to "Financial institutions for small business (1-2-1-4) sub-sector under banks
(1-2-1). Major transactions of the postal savings are summarized as follows.
wings refe
ti
© Postal savings accept savings deposit
accrued.
from households and pay interests
e Sa cal Loan Fund in the form of entrusted funds
or invested in bonds issued by the Fiscal Loan Fund, whic
out from the Fiscal Loan Fund to the government financial institutions.
vings are lent out to the Fi
are further lent
© Postal savings receive interest from the entrusting funds and investment
in the Fiscal Loan Fund.
Insurance Companies
j
Insurance ies sell insurance
range of financial products. They are obliged to pay a part of funds as insurance
policy. Major transactions of insurance companies are summarized as follows.
's and manage investments to wide
e Insuranc eceive insuran
ompani ce policy funds from households, which
ot of houscholds and liability of insurance companies. Thi
called Insurance reserves.
re
These funds are lent out to households and producers, or invested in gov-
ernment securities, corporate bonds, stocks and foreign financial securities.
¢ Insurance companies receive interest and dividend payments from these
financial investments.
They cover insured poli sts to contractors. At this
they are assumed to be a cons
ant amount.
18
Pension Funds
Pension funds are important economi s in modern economy that inves'
accumulate from pensions and lump-sum retirement benefits. Exam-
tor includes corporate pensions and other pension funds. It needs
managed funds such as Em-
ployees’ pension funds and other retirement pension plans, which are different
from public social pension funds ultimately administered by the government.
Major transactions of pension funds are summarized as follow:
ples of thi
to be noted that this pension funds are private
¢ Pension Funds mainly receive funds from producers who deduct them from
their employee incomes. However, in the model, houscholds as employees
also make private pension payments to the funds.
e funds are im
Thes ted as portfolio investments among government s
curities, corporate bonds and stocks, foreign financial securities, ete.
Pension Funds receive interest and dividend payments from these financial
investments.
They pay annuities to the retired households (which are assumed to be a
constant value in the model).
Securities Investment Trusts
investment trusts are investment trust management compani
se funds by issuing investment trust beneficiary certificates. They fun
as an another type of financi ion. Major transactions of securities
investment trusts at this stage of research are summarized as follows.
1 intermedie
© Securities investment trusts issue investment trust beneficiary certificates
and receive funds from investors such as households, insurance companies
and pension funds
¢ They make investment in foreign financial securities. (At this stage, no
revenues are assumed).
Nonbanks
Nonbanks are private institutions that raise funds other than accepting deposits
or deposits-like instruments, and make investments through lending. They con-
stitute an important financial sector through which massive amount of liquidity
is provided into property markets in Japan (that has led to the formation of
property bubble in the 1980's). In the model, their source of funds is through
bank loans. Major transactions of nonbank are summarized as follows
Nonbanks raise funds by borrowing from banks at interest.
« They lend out these deposits to households in the form of consumer credits
and mortgage loans. They also make loans to producers at interest.
19
Their main source of income is the interest spreads between bank loans
and their lending rate.
Fiscal Loan Fund
ment and Loan Pro-
Fiscal loan fund raises funds either by issuing Fiscal Inv
gram bonds (FILP bonds) or by accepting entrusted funds from the postal
savings and the social ity funds (3-3). Specifically, this sector includes
the Spe stment and Loans Program (Fiscal Loan Pro-
gram Fund Account). Major transactions of Fiscal Loan Fund are summarized
as follows.
« Fiscal Loan Fund issues its bonds and receive funds from the Postal Sav-
ings.
@ It also receives entrusted funds from the Social Security Funds and Postal
Savings at interest (which is not included at this stage).
e It lends out these funds to the Government financial institutions and re-
ceive interest. Its interest spreads become its main source of income.
Gove Fi ial Institutions
Government financial institutions are public financial institutions other than
the Fiscal Loan Fund. This sector includes, for example, Development Bank
of Japan Inc, Japan Finance Corporation and other government-affiliated in-
apan Housing Finance Agency. Major transactions of the
al institutions are summarized as follows.
stitutions such as
government finane
eceiving entrusted
(bonds).
¢ Government financial institutions raise their funds by r
ing public corporation securities
fiscal loan funds or by i
« They lend out these funds to producers and households.
e They receive interest income from these loans.
Financial Dealers and Brokers
ial dealers and broke
According to the above Guide by the BOJ, "Finan are
defined as institutions that mainly engage in dealing and broking of financial
instruments. This securities companies, money market dealers
and Banks’ Shareholdings Pu Corporation. Major transactions of the
financial dealers and brokers in the model are summarized as follows.
sector includ
¢ Financial dealers underwrite corporate bonds and newly issued stocks, and
sell these securities to other sectors.
They also handle government securities through reserves account at the
central bank.
20
e They receive interests and commissions from the business of these financial
securities
« They borrow from banks in case of the shortage of funds. (At this
of research, the amount of funds they borrow from banks is assumed to
be exogenously determined.)
stage
Social Security Funds
Social security funds receive ach as public pensions collected by
the government. They manage a large amount of public pension funds (assumed
to be fully collected from households in the model. These funds are then invested
as their portfolio management among financial securities. Maj
of social security fund are summarized as follows.
@ Social
vestment
securities and foreign financial securities.
al insurance
0c
arity funds manage pension funds from houscholds and make in-
among treasury securi public corporation
e They also lend out these funds to the Fiscal Loan Fund.
Overseas
To avoid further complexity of transactions at this stage of research, transactions
of overs inly confined to the trades of goods and services, which are
exogenously defined in this model. It also needs to be noted that, as a result of
and financial investment by domestic cantly large
apital outflows into overseas sector in the model. Transactions of
tor are summarized as follows.
s are mi
foreign dire sectors, a signifi
amount of
overse
© Overseas import and export goods and services from domestic producers.
e They receive funds from domestic sectors as financial investment.
6 Validations of the Model
ASD macroeconomic model at this stage has 179 stocks, 590 Auxiliaries, 44
table functions, 244 data and 374 constants (Total 1431 symbols), many of
which are inter-connected through transactions of bank deposits and reserves at
the central bank. Accordingly, model validations become crucial before we move
to the next stage of development. They are carried out through the following
four steps.
Validation 1: Built-in model checks
There are two built-in model checks in Vensim software that is used for this
arch; that is, Check Model and Check Unit. Our model has cleared these
ck points.
21
Validation 2: Balance sheet checks
Throughout the transactions balance sheets of all 15 sectors have to be in bal-
ance between total assets, and sum of liabilities and net assets (equities and
retained earnings). Our model has cleared these balance sheet (B/S) checks of
all sectors.
Validation 3: Flow of funds checks
There are 23 different transaction items in the model. Inter-sectoral sums of
these assets and liabilities have to be in balance, transaction by transaction. For
example, demand deposits of banks as bank liabilities have to be equal to the
sum of all demand deposits among non-bank sectors as their assets. Moreover,
reserves of banks at central banks (liabil has to be equal to the sum of
nt banks and reserves of financial dealers and brokers (assets).
As an another example, those newly issued capital stocks, which are treated
as net asset item of producers (only producers issue corporate capital stocks in
the model) are held by other sectors such as banks, insurance companies and
pension funds, ete. at the same time. The sum of all capital stocks being held
by them should be in balance with that of capital stocks issued by producers
(net asset). (However, only in this case stock market value variation has to be
also taken into consideration for the validation).
Our model has cleared all these inter-sectoral flow of funds (FoF) checks.
reserves
Validation 4: Model reality checks
Negative values of stocks are tolerated for the model validations discussed above,
However, negative values have no real economic senses. Accordingly, our fir
check is t6 find out if stocks of asset and liabilities take non-negative values.
There are some exceptions, s of the government
are allowed to take negative values, because it keeps borrowing and its debt
level continues to accumulate exponentially. Accordingly, this in turn implies
that the government is under the water due to the accumulated debts?
Our model has cleared these reality checks.
however. For instance, net a
Remarks on the System Boundary
Our ASD macroeconomic model has 374 constant values. In system dynamics
they represent system boundaries of the model. Among those boundaries, the
most essential boundary is trades of goods and services with overseas. Real data
of imports and exports are used in the model. In addition, quite a few stock data
among financial sectors are used as variable data at this stage of development.
5s a matter of fact, only the government is allowed to run under water, because it has to
be the last borrower to provide the enough money stock under the current fractional reserve
banking system. This causes a fundamental inci es of system design of our current
debt money system.
22
These boundaries will be removed one by one as our model construction proceeds
in the future.
7 Getting Data into the Model
7.1 Data Inconsistencies
Our second stage of this research is to get macroeconomic data as reference data
and/or variable data not only from the FFA but also from the SNA ma
nomic database as well as population data from the government statistics office.
Various data sources utilized in this research are listed as follows:
‘oeco-
Flow of Funds Accounts developed by Bank of Japan
(http://www.boj.or,jp/statistics/sj/index.htm/)
Annual Report on National Accounts by Cabinet Office, Government of
Japan
(http://www.esri.cao.go,jp/jp/sna/data/)
Economic data released by Minis
(http://www.mof.go.jp/statis
ry of Finance
)
Population data available from Ministry of Internal Affairs and Commu-
nications
(http://www. stat.go.jp/data/jinsui/)
of sectoral balance sheets that have both financial and real stock values in a
uniformed framework.
Accordingly, it becomes nec
of Funds Accounts, real economi
of major macroeconomic data such as GDP, det:
government statistics data including debts data fom the Ministry of Finance
y to integrate financial date from the Flow
data from the National Accounts consisting
ed Social Trans! well as
Statistics
‘As a result, we have encountered difficulties of data inconsistencies. An
example of such data inconsistencies has appeared from the data on Capital (PP
& E) when we tried to estimate macroeconomic production function. Capital
stock data from the SNA accounts differed between 2000 base and 2005 base,
as well as the capital stock data we have calculated by their flow (investment)
data from the same SNA data. In this case, we have decided to use the capital
stock data based on our integration of their flow data.
The other example of data inconsistencies occurred among the money stock
data by the BOJ. Original time series data available from BOJ consists of 3 dif.
ferent periods. Thus we have combined those original data into one continuous
money stock data.
23
7.2 Limitations of Net Flow of Funds
The Flow of Funds data by the Bank of Japan provides us with important
economic information for our research. Yet, there are scrious limitations when
applied to our modeling approach. Specifically, data for financial tra:
are provided as stock values and their net flows, simply because net flows are
culated as the differences between this year’s stock values and those of previous
year.
This method of calculation result in two difficulties in constructing the ASD
model. First, exactly the same stock values can be produced by the same net
For instance,
but by the different combinations of inflow
in Figure 6, the same net flows of revenues (lines 3) are shown to produce the
same convex-shaped stock values of retained earnings that increase first, then
later (lines 4). These same stock behaviors, however, can be caused
cither by decreasing inflow of revenues (line 1) with constant outflows of costs
(line 2) in the left-hand diagram, or by constant inflow of revenues (line 1) and
sing outflow of costs (line 2) in the right-hand diagram.
Stock-Net Flow Relation ‘Stock-Net Flow Relation
2 oat PTT 200 ant
0 unit mt | |} 50 init
“Rtaaed Farinas” = Cart
Figure 6: Limitations of Net Flow Analysis
culated from the
become ly the same, and it becomes impossible to identi
of the increasing-then-decrease behaviors of the retained earnings (stock values)
Accordingly, if these net flows are ce ame stock values, they
the real
just by observing the same net flow values of data per se. Without knowing
real s that produce the convex shape of retained earnings, no eff
policies can be suggested to prevent the decrease in the retained earnings; that
is, whether to stop decreasing revenues or to stop increasing costs.
Second, stock values in the FFA are calculated from financial statements or
sheets of all related sectors. According to this nature of data calculation,
no data of inflows and outflows of each financial transactions are difficult to be
balance
identified. Moreover, it is almost impossible from publicly available data to
identify where transaction funds come from as inflows and where to go out as
24
outflows. For instance, bank loans are made to several sectors and repaid by
several sectors. Each sector has different historical behaviors in terms of inflow
stock and net flow data on the bank loans are insufficient
s and those of outflows.
Figure 7: Financial Assets and Liabilities by Sector, p.5 (March 2014), BOJ
Figure 7 from the Guide of the FFA demonstrates how the Bank of Japan
struggles to illustrate the flow of funds among major sectors and sub-sectors by
using sectoral balance sheets of assets and liabilities. It reveals the limitation
of the FFA data for explaining inflows and outflows of funds among sectors.
These limitations have become serious obstacles for modeling financial trans-
25
actions with stock and flow structure of system dynamics. Therefore, it has been
a very painful process for our research to overcome these limitations and con-
nect all inflows and outflows of transactions among 15 s. We have tried to
connect them according to our rational reasoning and behavioral assumptions
of economic sectors. These connections have successfully completed the second
stage of our model development.
7.3. Hidden Manipulation of Special Taxes Revealed
Whenever government budget is discussed in Japan, it usually refers to the
general government budget publicized by the Ministry of Financ
tax revenues in 2014 were 54.6 trillion yen, and government expenditures were
72.6 trillion yen, resulting in the primary balance deficit of 18 trillion yen.
Accordingly, the government is forced to borrow 41.3 trillion yen, including
debt repayment and interest. These figures on government budget are the ones
repeatedly covered by media and macroeconomic textbook.
Yet, in reality the government levies more taxes under the name of Special
Taxes, which has been cunningly hidden from the public eyes and budgetary
discussions on the Diet. For instance, in addition to the income and consump-
tions taxes that show up in the general budget, Japanese households have been
forced to pay special taxes such as automobile taxes, airport taxes, highway
taxes, etc.
For instance,
In fac!
scording to the data from the Ministry of Finance, government
revenues in 2012 were 376 trillion yen, while its expenditures were 332 trillion
yen, attaining 44 trillion yen surplus. Th
above government’s general income reports . Accordingly, special taxes have
never been examined and debated openly on the Diet, nor paid attention by the
public. In other words, those taxes have been privatized by the government’
bureaucrats as if they are special budgets for their own private use.
Among the developed OECD countries, Japan is the only country, to the best
of our knowledge, which adopts such a dual taxation and budget system. This
hidden tax system which has accumulated hidden surplus has been deceiving
the public as if the government is suffering from deficit every year. From the
system’s points of view, such dual tax
reformed drastically to attain the efficie
Japan.
It turned out that the ASD macroeconomic model cannot attain data con-
tencies of the macroeconomic behaviors unless it integrates both general and
al taxes. Without bringing the role of these hidden special taxes to the
data consistenci
ese data have been hidden from the
system has to be either abolished or
and openness of public pol:
in
‘ies of our model has never been attained. In this s
the ASD model has revealed the hidden role of special taxes at the macroeco-
nomic level. It advocates the integrated and more effective use of budgets by
the government. The government will no longer be allowed to hide special tax
revenues behind the screen in the face of the accumulating debts.
ense,
26
8 Behaviors of Data as System Design Failures
8.1 Five System Design Failures
With the imported data in our model, we are now in a position to observe
macroeconomic behaviors such as GDP (line)1, Mp (line 2), Mi (line 3) and
debts by banks (line 4), by producers (line 5) and by government (line 6), as
illustrated in Figure 8, with an expectation that these data analyses may help
understand why Japanese economy has been trapped into the so-called "Lost
Two Decades” since early 1990s.
GDP, MO, M1 and Debt (Producers & Government)
800,000
600,000
4
£400,000
&
200,000
0
1980 1985 1990 1995 2000 2005 += 2010~—=«2015
Time (Year)
"GDP (Revenues): JapanDuke)
*Monaiary Base (MO): JapanDataRef)
SapunDataeh
mena
Figure 8: Japanese Bubble and Burst followed by Lost Two Decades
From the observation of these data, we have identified five abnormal macroe-
conomic behaviors of Japanese economy as system design failures of the current
debt money. In section 1, we have already pointed out two fundamental
design failures, that is, monetary instability and government debt:
the current debt money s y are the ones originally indica
[1], etc. in 1930s after the Great Depression in 1929.
These five system design failures are illustrated in Figure 9, out of which two
of them numbered (1) and (3) may overlap the two fundamental system design
failures pointed out by Fisher, etc. The remaining failures supplement them.
Let us now discuss them one by one.
8.2 System Design Failure 1: Bank Loans ~ M;
The first system design failure claims that the current debt money system trig-
gers economic bubbles and bursts repeatedly ussed in Figure 1.
Bubbles are caused by excessive loans (credits out of nothing) by banks, fol-
27
(Bank
Loans
Quantity Theory of Money:
MV =PT (-GDP)
Time
Deposits
“posit a)
@) Government
Base (MO)
QE jase (MO)
Policy ———™
Figure 9: Five System Design Failur
lowed by an increase in money stock M;. Their bursts destroy M1 due to the
forced repayment of loans (credits), causing economic recessions. Having faced
with the Great Depressions in 1929, Irving Fisher [1] demonstrated that these
economic booms and recessions are caused by the fractional reserve banking
em.
Line 4 in Figure 8 represents total amount of loans (or credits) by banks,
while line 5 represents debts of producers from banks. They began to increas
swiftly in late 80s and suddenly stop in early 90s, then collapse in late 90s. They
illustrates how quickly bank loans have contracted during the middle of 1990s
just after the bubbles burst. Even today, Japanese economy is suffering from
these collaps
Meanwhile, money stock M, is illustrated by bold line 3°. It has been
constantly increasing. If Fisher’s above observation were correct, money stock
M, in Japan would have also collapsed after the bubbles burst,
decline in GDP.
The relations between bank loans, producer debts and money stock Mj are
illustrated as phase diagrams in Figure 10. Under the debt money §
money stock is created out of nothing when banks make loans, and destroyed
when loans are repaid. This instability of M, has been the root cause of eco-
nomic booms and recessions as pointed out by Fisher, etc. In the above phase
diagrams, these relations are represented by the upward-sloping lines. That is to
say, whenever banks make loans by creating credits out of nothing, M increases
simultaneously, and vise versa. This instability of M, caused by bank loans
itself the most serious system design failure under the debt money system.
However, when bubbles in Japan popped in early 1990s, and bank loans and
producer debts began to collapse, M, didn’t decline as expected by the monetary
ent
2
causing rapid
®A sudden increase in M; around 2004 shows that some discrepancies of monetary data
have been adjusted around that time mainly due to the privatization of Japan Postal Savings
as explained in section 5.2.
28
Eien Diagram: Henke Leena eT Phase Diagram: Producer Debt —> MI
_sno00 lie ) 4s0000 =
sat — =
a a aa ail
Figure 10: Phase Diagrams of Bank Loans and Producer Debt vs My
instability of Fisher, etc. Instead, it began to increase as the downward-sloping
lines in Figure 10 ind are unexpected behaviors. Why
didn’t se along the upward-sloping lines as bank loans and producer
debts continue to collapse?
e. These abnormaliti:
8.3. System Design Failure 2: Time Deposits ~ M,
The answer for increasing M, against the decrease in bank loans could be par-
tially found in the behaviors of time deposits. Figure 11 is produced by replacing
lines 5 and 6 in Figure 8 with time deposits by banks (line 5)” and money stock
Msg (line 6). Mg is defined as the sum of M, and time deposits.
GDP, MO, MI and Time Deposits
13M
975,000
325,000
0
1980 1985 199019952000» 200520102015
Time (Year)
“GDP (Revenues): opanDta
"Monetary Base (MO) JapanDataRef)
TapunDataed
Figure 11: Monetary Base, Money Stock and Time Deposits
‘A sudden increase in time deposits around 2007 indicates their amalgamation with Japan
avings due to its privatization
29
In the figure bank loans (line 4) and time deposits (line 5) move in the same
direction. This implies that whenever bank loans soar, money stock M; also
grows, causing houscholds to increase time deposits simultaneously during the
normal period.
When bubbles burst, depositors try to withdraw their time deposits to com-
pensate for their lost demand deposits due to the decline in bank loans. Thi
why time deposits continues to decrease (line 5) along with the collapse of bank
loans (line 4). It is additionally observed that total amount of money stock Ms
continues to grow or sustain its level throughout economic depr
The relation between time deposits and Mj, can be better presented by the
left-hand phase diagram in Figure 12.
During the normal time, this relation is shown as an upward-sloping line.
That is, time deposits increases along with the increase in Mj; that is, house-
holds save more as more money stock becomes available, and vice versa.
On the other hand, as a steep downward-sloping line impli
are forced to withdraw their time deposits in order to increase their demand
deposits and meet economic difficulties during the recessions after the bubbles
popped. Hence, the steep downward-sloping line indicates that, along with the
collapse of bank loans, a large amount of time deposits held by banks (mainly
by households) were transferred to demand deposits’. Withdrawals of time
from higher savings in Japan could be indeed said to have contributed
¢ in M,, which in turn sustained GDP. This abnormal behavior of
households in Japan explains why Mj didn’t decrease even though bank loans
were repaid and credit crunch is concurrently triggered. In this sense, due to
the higher savings the instability of M; cause
system design failure, worked positively in Japan during the abnormal period
of economic recessions.
‘ions.
, households
save Disgranny Time Depooits “= MI Phase Diagram: Government Debt -> M1
—— =e
Figure 12: Phase Diagrams of Time Deposits and Government Debt vs My
8A sudden jump of time deposits after 2008 in data indicates the integration of time
deposits by banks sector with the Postal Savings which was privatized by that year.
30
8.4 System Design Failure 3: Government Debt ~~ 1,
The withdrawal of time deposits only explain a part of the increase in M,
against the collapse of bank loans (credits). The main reason for the increase
in M, could be explained by the increase in government debt. In fact, it has
continually increased from 53 trillion yen in 1980 to 730 trillion yen in 2014.
According to our simple calculation, it increased by 32.5% annually between
1970 and 1979, by 8.3% between 1980 and 1999, and by 3.3% between 2000 and
2014.
Accordingly, as explained in Figure 1, government debt increases My. The
relation between treasury urities debt and Mj, can be better illustrated by the
upward-sloping line in the right-hand phase diagram in Figure 12. This makes a
big difference of monetary behaviors between the Great Depression in 1929 and
the Lehman Shock (called the Second Great Depression) in 2008. As a price of
this incessant borrowings, government is now facing serious debt In fact,
government debt surpassed GDP in 2005 (Debt-GDP ratio becomes more than
100%), and continues to accumulate at an unstoppable rate. Yet, it failed to
stimulate GDP. Accumulation of government debt constitutes the third system
design failure in the debt money
8.5 System Design Failure 4: My ~ M,
Under the current fractional reserve banking system, someone has to keep bor-
rowing to sustain money stock. Someone could be producers, households or
government. As Figure 3 above indicates, producers and houscholds stopped
borrowing when bubbles burst. In fact, in the middle of 1990's, loans made by
financial institutions to producers began to decrease. Therefore, the government
must be the last and the only borrower to sustain the collapsing money stock
and economy.
In this way, due to the accumulating borrowing by the government, money
stock managed to increase as discussed above, which in turn prevented a decrease
in GDP. In comparison, during the Great Depression in early 1930's, money
stock shrank rapidly so as to reduce GDP by more than 30% in the US. Without
the increasing government debt, GDP in Japan would also have plummeted
drastically.
Yet, an increase in M, has not been large enough to drive GDP to grow as
to be explained below. To increase My furthermore, QE policy of expanding
Mo has been intensively introduced as discussed in section 1. Left-hand phase
diagram in Figure 13 shows the relation between monetary base (Mp) and money
stock (Mj). Under a normal economic condition, it has an upward-sloping
relation as illustrated in the left part of the line. After the bubbles burst,
however, the rapid increase in Mo, due to the re-activated QE policy by the
Bank of Japan during the last two years from 2013 to the present day, failed to
stimulate My, This abnormal behavior demonstrates the fourth system design
failure in our debt money system.
Phase Diagram: MO —> ML
wloet ain i
Phase Diagram: MI -> GDP.
"Monetary Base (M0 “ 4568 erry
Figure 13: Phase Diagrams of Mp vs Mi, and My vs GDP
8.6 System Design Failure 5: iM, ~» GDP
The above QE allegation that the incre
and stimulate GDP has overlooked a decisive fact shown in Figure 8 that GDP
(line 1) stopped growing despite of the increase in Mj since around 1995. This
relation can be better illustrated by the right-hand phase diagram in Figure 13,
in which the relation between My and GDP is shown to be upward-sloping for
sed Mp will in due course expand M,
a while, then it becomes flat all of a sudden, though it never got plummeted
furthermore under the collapse of credit crunch.
This constitutes the fifth system design failure in the current debt money
system. How can the increase in Mj stimulate GDP, then ?
9 Real Macroeconomic Behaviors
So far our analyses are based on the behaviors of the imported monetary and
economic data. Now we are in a position to challenge the question raised above:
how can the increase in M, stimulate GDP? To answer the question, however,
we have to understand system structure of Japanese macroeconomy that relates
behaviors of M, and GDP. More specifically we have to explore the interde-
pendent relations that affec
in section 1. Why did producers stop borrowing even though interest rate (and
capital costs) is close to zero? Why did QE policy fail to increase corporate
borrowing as well as mon Ak? These questions continue endlessly toward
better solutions by running simulations.
This leads us to the third stage of development; that is, a proc
them, and challenge the related questions posed
of model
optimization with real economic data. Figures presented below show some of
ssful optimization results. They are obtained by partial optimization
sses of data interpolation. By partial optimization it is meant that only
ly related parameters for interpolation variables are picked up to obtain
optimum values. Control parameters we have used for optimization are the ones
already presented in the generic models in the book [3, 2013]. This may show
the robustness of the generic models in the book as base macroeconomic models
of actual economies.
By observing data behaviors of the model, we have realized that our partial
optimization could be effectively performed if a structural change in Japanese
economy is considered. Accordingly, we have created two categories of param-
eter values for two structural changes; that is, bubbles and their bursts. Eight
figures below show our optimization results for such variables as nominal and
real GDPs, price, prime rate, consumption, private investment, population, em-
ployed labor and unemployed labor.
GP (Revemes 0 a)
pie eel in
eum }
i F
2DP Rms ape
"UDP reap aac
Figure 14: Nominal and Real GDP
a a PAC =
Figure 15: Price and Prime Rate
From these optimization processes, we have found interesting behavioral
changes among producers, households and government before and after bubbles
burst. Behavioral changes of private investment took place in the year 1990.42,
those of consumption took place in the year 1991.75, and finally those of gov-
ernment spending took place in the year 1999.87. Producers are affected first
by the burst of bubbles,
government is forced to y
of bubbles. In short, it is observed that there exist some delays among economic
tors for their behavioral changes against the burst of bubbles.
ars later. Finally
er after the burst
Consumption Private Investment
eoatrey Ree
Comer: Curt
‘rate inet lpuaDafha) >see
Figure 16: Consumption and Private Investment
Population and Employed Labor ‘Unemployed Labor
ee te * —
“a avn
-. pga et [ard i
Epbyed Labor puna
Populi 15 To 64 apenas)
Figure 17: Population, Employed and Unemployed Labor
10 ”What if ?” Macroeconomic Behaviors
Sustained Investment and Economic Growth
The ASD macroeconomic model of Japan, if completed, will be able to answer
the "What if ?” macroeconomic behavioral questions that have been so far
considered impossible in social science. For instance, what would have happened
with GDP if the private investment were sustained by the same behaviors of
investment activities before the bubbles burst? Line 3 of the left-hand diagram
in Figure 18 illustrates such a situation in which private investment levels of
producers were sustained. Line 3 in the right-hand diagram then shows how
nominal GDP would have increased to about 900 trillion yen, or 80% incre
if producers would have maintained their investment behaviors.
If so, the next question would be, then, ”How such investment levels could be
sustained? These are challenges we will tackle at our next stage of development.
Private Investment GDP (Revenues)
re ce eat
“UDP Reems) eh
Figure 18: What if? Simulations for Investment and GDP
11 Conclusion
The purpose of this research is to develop a comprehensi
model of Japan that incorporates both real and financ
huge model-building project, it is broken down into 6 stag paper reports
its carly stage of development from the stage 1 through 3 partially. At the first
ch, we have developed a basic framework of the model on the
em dynamics approach. As a base model, the generic
model used in Chapter 9 in the book [3, 2013] is revisited. It
macroeconomic
has 5 economic sectors. Then, it is extended to 15 s
items. Along with these model extensions, four model validation checks are
performed
At the nd stage, a large amount of data from various s > im-
ed from the
ported to the model. Various economic and social data are colle
Flow of Funds Accounts by the Bank of Japan, SNA data by the government
and Ministry of Finance. At this stage we have faced some difficulti used by
data inconsisten and the nature of flow data as net flows. Then, with the im-
ported data, we have observed macroeconomic behaviors of data and identified
five system design failures in our current debt money
At the third stage, partial optimization proc
for the interpolation of various real macroeconomic variables
and real GDPs, price, prime rate, consumption, private investment, population,
employed labor and unemployed labor.
This paper tries to report our early stage development of ASD macroec
nomic model of Japan by focusing on the recent QE policies as an example of
system design failures, with a hope that the model, when completed, will reveal
our macroeconomic system structures that have caused design failures so that
we could draw a better macroeconomic system design.
lly performed
such as nominal
References
[1] Inving Fisher. 100% Money. The City Printing Company, New Haven, third
edition, 1945. First edition (1935) available through ThaiSunset Publica-
tions, 2011.
N
Michaele McLeay, Amar Radia, and Ryland Thomas. Money creation in the
modern economy. Bank of England Monetary Analysis Directorate, Quar-
terly Bulleting, 2014 QL.
[3] Kaoru Yamaguchi. Money and Mac Dynamics ~ A ing Sys-
tem Dynamics Approach. Japan Futures Research Center, Awaji Island,
2013.
[4] Kaoru Yamaguchi. From debt money to public money
a transition proce
Conference of the System Dynamics Soc
System Dynamics Soc
em — modeling
simplified. In Proceedings of the 32nd International
ety, Delft, Netherlands, 2014. The
36
Appendix: Major Sector Models Illustrated
In this appendix, GDP determination and original 5 sectors are illustrated such
as Producers, Households, Government, Banks and Central Bank. And the
remaining 10 sectors are not presented here due to the limited page s
Readers are referred to the model in the book [3, 2013] to compare how the ASD
macroeconomic model of Japan has extended the transactions of the original 5
macroeconomic sectors.
To avoid the complicated spaghetti diagram of crossing flow arrows, in the
figures below we have tried to use as many shadow variable as possible and
hidden some inessential arrows into the lower depth.
Figure 19: Determination of GDP
37
i
l
|
TL
Figure 20: ASD Macroeconomic model of Japan
38
Figure 21: Extended Transactions of Producers
39
Figure 22: Extended Transactions of Households
40
Figure 23: Extended Transactions of Government.
41
Figure 24: Extended Transactions of Banks
42
Figure 25: Extended Transactions of Central Bank
43
